Microsoft (MSFT) Window of Opportunity?

by riskreversal September 30, 2016 2:13 pm • Trade Ideas

The biggest news in tech this week was merely rumor, that Qualcomm (QCOM) is in talks to pay $30 billion for NXP Semiconductor (NXPI), a company which just last year spent $12 billion to buy Freescale Semiconductor. As the Wall Street Journal described yesterday, QCOM which is heavily dependent on design & licensing of mobile chips (they are fabless), buying NXPI:

would expand Qualcomm’s chip business from dozens of major product lines to hundreds spanning many industries outside mobile devices. It would instantly become the No. 1 supplier of chips used in cars—one of the hottest target markets for semiconductor makers—hoping to benefit as automobiles add greater computing power and self-driving models develop.

So such a deal would be about the next 20 years in tech, not about shoring up market share earned in the last twenty.  Much of the near $200 billion in semiconductor M&A since the start of 2015 has been just that, as PC and Smartphone markets mature, component suppliers are desperate to diversify into emerging technology products & platforms like the artificial intelligence (AI), augmented & virtual reality, Internet of Things (IoT), on demand cloud services, autonomous cars, drones etc. To refresh your memory, here are some of the tickers that no longer exist on your quote screens:

Analog Devices (ADI) is making a near $15 billion offer to acquire Linear Technology (LLTC)

ARM Holdings (ARMH) of the U.K. agreed to be acquired by Japan’s Softbank for $32 billion.

Western Digital (WDC) paid $16 billion for NAND flash chip maker Sandisk (SNDK)

NXP Semiconductors (NXPI) made a nearly $12 billion bid for Freescale (FSL)

Avago Technologies (AVGO) paid $37 billion ($17b cash & $20b in stock) for Broadcom (BRCM)

Intel (INTC) bought Altera (ALTR) for $17 billion in all cash

And it’s this last one above, INTC for ALTR got me thinking about Microsoft.  Aside from the QCOM/NXPI rumor, the other big piece of news in tech was MSFT’s reorganization of its Artificial Intelligence divisions, sharpening the company’s focus on emerging technologies, per the WSJ:

Microsoft is racing to ramp up its capabilities in this area, where Alphabet Inc.’s Google division, Inc., Apple Inc., Facebook Inc. and many others are investing heavily. Mr. Nadella has made artificial intelligence a cornerstone of the company’s strategy to lure customers to its cloud-computing services.


“We are on the cusp of a paradigm shift in computing that is unlike anything we have seen in decades,” Mr. Nadella wrote in his email to employees about the executive changes.

Here is a great read from Wired on the lead up to these organizational changes: Microsoft Bets Its Future on a Reprogrammable Computer Chip. And here was the quote that got me thinking that if semi m&a is being driven by new found focus of companies like MSFT there is little reason (in this environment) why MSFT couldn’t trade back to its all time highs of $60, and possibly higher with a lil’ multiple expansion:

Shares of MSFT, up 3.6% on the year are under-performing the S&P 500 (SPX) and the Nasdaq Composite (CCMP) up about 6.2%, despite only being 2% from its 52 week highs made in August at $58.70.  The stock has decent near term support between $56 and $7, but the next real support comes back towards its July earnings gap, very near its 200 day moving average at $54ish:

MSFT 1yr chart from Bloomberg
MSFT 1yr chart from Bloomberg

Here is one thing that I feel fairly safe saying, before this market cycle is all said and done, MSFT will make a new high, which has been in place since the last tick of 1999, on Dec 31st at $59.97!

MSFT 20 year chart from Bloomberg
MSFT 20 year chart from Bloomberg

The next identifiable catalyst for MSFT will be its fiscal Q1 results on October 2oth.   When the company reported their Q4 back in July that beat expectations, they might have pulled forward some demand in an attempt to close out their fiscal year, and given the billings commentary from (CRM) a month ago, it might suggest some softness in enterprise software spending. But given some new focus on what should be high growth initiatives, investors may look beyond current headwinds.

Make no mistake, just as the stock is approaching historical highs in terms of price, it is doing so in valuation, trading nearly 20x expected fiscal 2017 eps of $2.90, only growing 4% yoy on 2% sales growth.  Oh and regular readers also know that we are not fans of MSFT’s $26 billion bid for LinkedIn (MorningWord 6/13/16: $MSFT gets $LNKD).

So the stock is expensive to the market and its own history, recently made the largest and fairly questionable deal of its existence, trades very near an all time high, and the broad market could be in for some volatility. Oh, and current trends in tech suggest that m&a might be getting a little frothy, like a game of musical chairs that feels less than bullish. But, I am not sure how the stock does not make a new all time highs in a market that remains bid through the election and a passive Federal Reserve (until mid Dec), and I’m certain will do so if Q1 results and forward guidance are even slightly better than expected.

So what’s the trade?

If you are just inclined to play for an earnings gap to new highs, or are long, worried about the issues detailed above, then you definitely want to define your risk.  I would merely target near the money calls in October expiration which will catch the earnings event:

MSFT ($57.50) Buy Oct 57.50 calls for $1.45

Break-Even on Oct expiration:

Profits: above $58.95

Losses: up to 1.45 between 57.50 and 58.95, with max loss below $57.50.

Rationale: risking 2.5% of the stock price, with a break-even up 2.5% defines risk near the highs in the stock in case of a market pullback while being there if the market and MSFT make new highs under favorable conditions into an earnings event the day before October expiration.